Is Hedge Accounting Designation Informative About How Firms Use Derivatives?

47 Pages Posted: 28 Mar 2014 Last revised: 16 Mar 2018

Date Written: March 1, 2014

Abstract

Firms use derivatives for a variety of purposes including hedging, speculating, meeting or beating benchmarks, and smoothing earnings. However, poor disclosures have made it difficult for the investors to identify the motives behind and the economic consequences of firms’ derivative use. We use the derivative disclosures required by SFAS 161 to examine whether the economic consequences and investors’ reactions to derivative use vary by the accounting designation firms use for their derivatives. We find that hedge designated derivatives are negatively associated with several measures of firm risk, suggesting that the accounting designation of these derivatives captures the intended economic use of these derivatives. However, while the majority of firms in our sample claim to use non-hedge designated derivatives only for hedging purposes, we find that such non-hedge designated derivatives are positively associated with several risk measures. We also find that investors price derivative gains differently depending on the derivative’s accounting designation. Overall, the results suggest that the accounting designation for derivatives is informative to investors as to how firms use derivatives.

Keywords: derivatives, hedging, SFAS 161

JEL Classification: M41

Suggested Citation

Manchiraju, Hariom and Pierce, Spencer and Sridharan, Swaminathan, Is Hedge Accounting Designation Informative About How Firms Use Derivatives? (March 1, 2014). Available at SSRN: https://ssrn.com/abstract=2417194 or http://dx.doi.org/10.2139/ssrn.2417194

Hariom Manchiraju (Contact Author)

Indian School of Business (ISB), Hyderabad ( email )

Hyderabad, Gachibowli 500 019
India

Spencer Pierce

Florida State University - College of Business ( email )

423 Rovetta Business Building
Tallahassee, FL 32306-1110
United States

Swaminathan Sridharan

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
Evanston, IL 60208
United States
847-491-8807 (Phone)
847-467-1202 (Fax)

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